emerging market bonds - All posts tagged emerging market bonds

Investors reversed course in January, pouring $18 billion into emerging-market stocks and bonds following outflows of $11 billion in December, according to the Institute of International Finance.

Observers cite the relative value among emerging market investments compared to other areas, though some countries are more attractive than others, says a story published in The Wall Street Journal. The broad interest also proved true among emerging market funds in recent weeks, with interest in Asia’s emerging markets, as we reported last week.

Reuters

An oil well in Colorado.

The iShares MSCI Emerging Markets ETF (EEM) is up 1% today, and is up 8.2% over 12 months. Over the past year, the best-performing emerging market stocks have been in India, especially smaller companies, and China. The iShares MSCI India Small Cap ETF (SMIN) is up nearly 88% over 12 months, and the Market Vectors China ETF (PEK) is up 58%. Conversely, the Global X FTSE Greece 20 ETF (GREK) — among the best performers today, up 8.7% — is down 41% over 12 months, reflecting the nation’s debt and austerity woes. And the Global X MSCI Nigeria ETF (NGE) is down 40% over 12 months, reflecting the pain of lower oil prices for the African oil exporter.

So what has changed in the minds of emerging market investors? WSJ writes that

“The European Central Bank’s decision last month to adopt a €1 trillion ($1.3 trillion) stimulus plan has helped ease fears of a global liquidity crunch that could hit emerging markets hard, traders and analysts said. In its monthly survey among emerging-market investors, Société Générale SA found nearly 70% of its clients were bullish about emerging markets in the near term, the highest reading since last March.”

Will the enthusiasm continue if oil prices continue their creep higher? Both the U.S. and international oil price benchmarks have moved past $50 per barrel. WSJ notes:

“Two-thirds of countries in the MSCI Emerging Markets Index were net oil importers as of late last year, including China and India, according to the U.S. Energy Information Administration.”

Indian soldiers assist Kashmiri residents with a raft during flood rescue operations.

Bank of America Merrill Lynch research today reminds investors how lucrative and how risky emerging market bond investing has been.

“From January 2001 to today, local currency bonds in the emerging markets generated a cumulative return of 199.3% for an un-hedged investor. This compares to 79.6% invested in U.S. Treasuries over the same period.”

Asia has the most local debt market issues, but capital controls make the region less accessible to foreigners, Merrill writes. Emerging Europe, the Middle East and Africa is the most accessible region. Latin America generally offers the highest yields and total returns. However, among the challenges to investing in local debt markets:

“Excessive inflow of capital strengthens currencies and interferes with economic policy. Sudden outflows have depressed lending, and triggered domestic financial volatility. In response to that, some policymakers have interfered and imposed measures to discourage such flows.”

The total global emerging market (GEM) domestic tradable debt universe increased 8% in 2013 to reach a new high of $14.5 trillion total debt outstanding. The stock of domestic sovereign debt rose 2.3% to $6.7 trillion in 2013. But yields have dropped with increased foreign investment. Merrill reports:

Domestic government debt accounts for approximately 53% of all GEM debt; domestic corporate debt at 47%.

“Since the summer of 2013, there have also been heightened concerns about the implications of tapering and rising developed market rates for EM local bond performance. Despite this, we have seen consistent inflows into local markets, picking up even more heavily in 2014. As a result, foreign investors have become a significant portion of the investor base in many local debt markets. This highlights the risk that outflows and foreign exchange hedging may have on prices if sentiment shifts.”

Brazil presidential candidates Marina Silva of the Brazilian Socialist Party and candidate Aecio Neves of Brazilian Social Democratic Party (PSDB) at a televised debate last week.

The inverted yield curve in Brazil means get more cautious on the nation’s bonds, especially with the October presidential election looming.

So writes Pavillion Global Markets, which reversed course from its opinion issued in May. Pavillion writes:

Investors and the market are “pricing in a considerable reduction in structural inflation” based on election-season reform promises and their impact on inflation. But ”it is time to move to the sidelines when it comes to Brazilian fixed income, as the big move has probably already happened, regardless of election outcomes. … Given the significant difficulty in engineering such reforms, this seems to us like a “buy the rumor, sell the news” type of situation. “

Pavillion adds:

“… one of our reasons for wanting to own EM local-currency fixed income in general was the significant yield compression that had occurred across the global fixed income space since the start of the year, making risk premia attractive in a number of EMs. … Back in May, we turned positive on EM local-currency fixed income, with a special emphasis on Brazil. We believed at the time that Brazilian fixed income had been de-rated and that risk premia were high in the country’s bonds, creating value. This was taking place in a context where we felt the Fed was not going to provide another shock to vulnerable EMs, while some incipient changes were happening across the EM space. This was especially the case in Brazil where Dilma Rousseff’s election momentum was beginning to lose steam, increasing the chance of market-friendly structural reforms. Since then, the bond market has moved considerably and we now feel that it is pricing in significant good news, and then some.”

Barclays lifted its recommendation on Indonesia to Overweight Thursday. With Joko Widodo the apparent winner in Indonesia’s 2014 presidential election, and his platform viewed as market-friendly, Barclays concludes that Indonesian spreads should gradually tighten further. They write:

“We revise our credit view on the Indonesia bond complex to overweight from neutral and recommend the long end – INDON 2044s, 2043s and 2042s and quasi-sovereigns – and buying Perusahaan Gas Negara (PGASIJ) 2024s.”

In Argentina, orderly debt negotiations and the status quo are likely. “Argentinean bonds have performed strongly on the back of these developments, and we maintain our positive view.”

Otherwise, emerging market credit markets have traded with relative calm this week, reflecting the prevailing low-volatility environment. Declining liquidity over the summer may be a concern, but Barclays says that with volatility close to multi-year lows, “the environment for spread and carry in EM still seems favourable.”

Barclays bond recommendations: Among corporates, sell Pemex or switch into peers such as Ecopet, Petbra (Petrobras (PBR)) or Sibnef. Among emerging market sovereigns. In addition:

“While we ecommend sticking to shorter-dated bonds in the 5-10 year sector in many benchmark names where curves are flat (eg, in South Africa, Turkey or Russia), we think duration extension into the 30-year sector looks attractive in Peru supported by the recent rating upgrade), Morocco and VALEBZ.”

Last year, emerging market bonds were one of the best performing asset categories. This year, they’ve offered little more than disappointment–especially for those invested in the bonds denominated in U.S. dollars.

ASSOCIATED PRESS

How badly have they done? The iShares JPMorgan USD Emerging Markets Bond (EMB) exchange-traded fund, which tracks the dollar-denominated JPMorgan EMBI Global Core Index, has lost 2.5% this year, after returning 17% in 2012.

Forget all the talk of an emerging-market bond bubble, however. Part of the loss is due to the fact that the bonds closely track U.S. Treasury yields because they’re issued in dollars. So with Treasury yields rising and prices falling–the iShares Barclays 7-10 Year Treasury Bond ETF (IEF) has dropped 1.3%, for instance–emerging market bonds have also taken a hit. And the difference between the yields on emerging-market bonds and equivalent Treasurys has also increased, says J.P.Morgan’s Joyce Chang in a report released this week.

Investors shouldn’t be worried, however, Chang says. She believes U.S. Treausry yields have moved too quickly, and will fall in the months ahead. Ultimately, dollar-denominated bonds could return 5% to 6% for the remainder of the year, she says.

Still, investors might be better off with bonds denominated in local currencies, Chang says. They should return between 8%-9% this year, with gains from both foreign currency and coupon payments. She also recommends increasing exposure to “higher-yielding credits,” like Venezuela, Angola, Gabon, Georgia, Dominican Republic, Indonesia and Sri Lanka. She also prefers high-yield corporates–including the debt of Venezuela’s PDVSA, and Brazil’sVale (VALE) and Petrobras (PBR)– to investment grade ones.

Of course, those bonds are high yield for a reason and they come with more risks than investors might be used to–especially if the recent drop in the dollar denominated bonds has proven too anxiety provoking. If that’s the case, best to stick with a nice, plain vanilla ETF like MarketVectors Emerging Markets Local Currency Bond ETF (EMLC), which tracks the JPMorgan GBI-EMG Core Index. It’s gained 0.35% this year after gaining 14% in 2012.

When it comes to the market risks in 2013, investors are focused on the big three: China, Europe and the U.S. But there’s a lot more that could go wrong–or right–next year, according to a report from Deutsche Bank’s FX strategistsreleased today.

Associated Press

Of course, these are “outliers” and unlikely to happen. But with the risks to the big three so well documented, it pays to think about the little things that could create big problems–or rewards.

Let’s focus on the negative first.

The Emerging Market Bond Bubble Pops: Everyone loves emerging-market bonds. Deutsche Bank’s strategists write that foreign investors have “buil[t] up their positions in EM local debt markets to new record levels,” spurred on by the demand for yield,” rates cuts by emerging-market central banks and the stronger emerging-market balance sheets. The only problem: Some say that emerging market bonds are in a bubble. If prices rise more than investors expect–watch out. It could cause a mass selloff that would be extremely painful for investors who are counting on funds like the Market Vectors EM Local Currency Bond (EMLC) exchange-traded fun, which has returned 15% this year, to produce another double-digit gain–or any gain at all.

Markets Decide to Take Climate Change Seriously: So far, markets have ignored the risks of climate change–but that could change, especially if the drought in the U.S., Russia and Brazil continue. If nothing else, volatility could rise.

China and the U.S. Duke It Out in the South China Seas: What could wrong? Plenty, the strategists say:

An increasingly assertive China, the US foreign policy pivot towards Asia, an ocean bed of potentially vast mineral reserves surrounded by fast-growing resource-hungry nations, disputed maritime boundaries, and fishing boats with tendencies to stray, all make for a combustible situation in the South China Sea.

Malaysia’s Government Loses Election: Elections must be called during the first half of 2013 and the power of the opposition has been growing. No one actually expects it to win, but if it does, expect Malaysian stocks to take a hit–especially government-run companies. The iShares MSCI Malaysia Index ETF (EWM)

Emerging-market bonds might hold up better than investors expect if the U.S.goes over the fiscal cliff, according to a recent Citigroup report.

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Bonds issued by emerging-market governments and corporations in their own currencies occupy a strange middle ground in the world of fixed income. On the one hand, they’re bonds that pay regular coupons, and thus offer a level of safety investors don’t have in stocks. But they’re denominated in local currencies, which means they can be far more volatile than the average bond–especially when the markets go into “risk-off” mode.

That puts investors in something of a predicament heading into year end. If Congress reaches a deal, then no worries. Local currency bonds should do just fine–and perhaps even better than their dollar denominated counterparts. But if no agreement is reached, the currency component could get hammered.

Citi’s strategists urge investors not to panic, however. The reason: Local-currency bonds held up during the debt ceiling debacle because the bond component offset the currency losses. From May16 through August 31, Citi’s Emerging Market FX index lost, at most 2%, but its Emerging Market Local Government Bond index gained 4% during the period.

Of course, the fiscal cliff could be worse than the debt ceiling crisis, the strategists say, so investors might want to cut back a bit before year end. Still, the report suggests investors who hold the Market Vectors Emerging Markets Local Currency Bond (EMLC) exchange-traded fund or the SPDR Barclays Capital Emerging Markets Local Bond ETF (EBND) might do well with just sitting tight.

Yields on bonds of all stripes near record lows–and the potential hit from rising rates is at at an all-time high. In this yield starved environment, investors should consider taking a larger stake emerging-market corporate bonds, UBS said in its December CIO Wealth Management report.

What makes EM bonds a better bet than other dollar-denominated fixed income? Emerging markets companies and countries are sounder today than they were, oh, 20 years ago. Twenty years ago, the average emerging market (EM) sovereign issuer of US D-denominated debt had a credit rating of B+. In other words, these issuers offered poor financial security with a small assurance of payment. Two decades on, EM sovereigns are rated BBB- on average and thus qualify as issuers offering adequate financial security with minor longer-term risks, according to rating agencies.

And the credit quality of emerging markets should continue to improve, UBS believes, applying continued downward pressure to yields. That would take the typical difference between emerging-market sovereigns and corporate bonds, on the one hand, and an equivalent U.S. Treasury, on the other, from about 3 – 3.5 percentage points down to around 1.5 percentage points.

That downward pressure should help these bonds absorb rising rates–when and if that time comes. The upshot: Emerging-market bonds are still one of UBS favorite asset classes.

If UBS is right, that would make exchange-traded funds like the iShares JPMorgan USD Emerging Markets Bond Fund (EMB) and the PowerShares Emerging Markets Sovereign Debt ETF (PCY) a valuable part of a fixed income portfolio, despite gains of 16% and 20%, respetively.

Looking to play the Venezuelan bond market, now that Hugo Chavez’sdays as president look to be coming to an end? Benzingahas a rundown of the ETFs, including the iShares Emerging High Yield Bond Fund (EMHY), which has 15% of its portfolio in the South American nation, and the Market Vectors LatAm Aggregate Bond ETF (BONO), which has 9.5% in Venezuela.

Venezuelan President Hugo Chavez is expected to undergo surgery in Cuba today to treat the return of his malignant cancer. Regardless of the outcome, analysts and portfolio manager are already trying to figure out what comes next.

In a note to clients today, RBS strategists say that new presidential elections are “a very likely scenario.” Part of this reason is the complexity of the Venezuelan constitution, which presents various scenarios for the transfer of power depending on the circumstances in which they occur.

The key takeaway however, is that “unless President Chavez is able to stay in power for at least another four years, which seems unlikely given his critical condition, new presidential elections will need to be held shortly after President Chavez steps down.”

Venezuela’s bonds have been trading up for weeks on hopes for a change from President Chavez to someone more, um, “business friendly.” The Barclays Emerging Markets Venezuela Bond Index has gained 13% since Nov. 15, driving yields down to 8.9%m from 11%.

That has some portfolio managers thinking it may be time to head for the exit. Alexander Kozhemiakin, head of emerging markets at asset-manager Standish, said in an interview yesterday that he was “leaning towards looking to take profits,” in part because the move has been so big and what comes next for the country is so uncertain. BBO Financial Services’ Russ Dallen, meanwhile, took profits yesterday.

Still with yields as high as they are–especially relative to the rest of South America–a selloff would probably create a new buying opportunity, Mr. Dallen said in an email. “…should Chavez go to meet his maker, Venezuela bonds will rally even further on the prospects for regime change to a more market-friendly system,” he says. “…in the longer run, Venezuela bonds will continue to make money for investors.”

About Emerging Markets Daily

Emerging markets have been synonymous with growth, but the outlook for individual nations is constantly changing. Countries from Brazil and Russia to Turkey face challenges including infrastructure bottlenecks, credit issues and political shifts. Barrons.com’s Emerging Markets Daily blog analyzes news, data and research out of emerging markets beyond Asia to help readers navigate the investment landscape.

Barron’s veteran Dimitra DeFotis has been blogging about emerging market investing since traveling to India and Turkey. Based in New York, she previously wrote for Barron’s about U.S. equity investing, including cover stories and roundtables on energy themes. Dimitra was among the first digital journalists at the Chicago Tribune and started her career as a police reporter at the Daily Herald in the Chicago suburbs. Dimitra holds degrees from the University of Illinois and Columbia University, where she was a Knight-Bagehot Fellow in the business and journalism schools. She studies multiple languages and photography.